From Bubble Watch to Bust Watch

Tim Geithner, Obama’s choice for Treasury Secretary, may not have seen the bust on Wall Street coming…but he promises action on a “dramatic scale” to fix it. That is probably what goosed-up the Dow yesterday – up 279 points. Oil rose to $43. Both gold and the dollar went down. The dollar fell to $1.29 per euro…while gold sellers got $5 less per ounce. The price of gold is $850.

“The End of the Reagan Era,” is how the French newspaper, The Liberation, described the handover of power to Barack Obama’s team.

The Liberation has it right. What we are witnessing is the end of an era. But it’s not exactly the era most people think. The voters made a big symbolic change when they elected Obama. But politically, Obama is not so different from Reagan, Bush I, Clinton or Bush II.

A much bigger change has just occurred – and gone almost unnoticed. This one was wrought not by the voters, but by Mr. Market. He has brought an end to the world financial system that arose during the Reagan years.

For the last ten years, these Daily Reckonings have been on Bubble Watch…watching…wondering…marveling…sometimes appalled…sometimes amused…

…what we were watching was the blow up of a crazy system of imperial finance, in which the world’s hegemony appeared to live at the expense of its rivals…and the imperial citizens – those in the homeland of the United States of America – drove themselves into bankruptcy so competitors could continue to sell their products at a profit.

It was strange. It was preposterous. But it wasn’t dull. We thought it was coming to an end in 2001…when the bubble in dotcoms blew up. Then, well, you know what happened…the feds got to work…and pumped up more bubbles. Now, the Bubble Epoque is nearly over. But Mr. Obama is jumping the gun…

“Starting today, we must pick ourselves up, dust ourselves off and begin again the work of remaking America,” he says.

Hold on…there are some huge busts that have to happen first… We’re watching for busts in U.S. government debt (U.S. Treasury paper)…the dollar…and finally, after a big run-up, gold. Then, Americans can rebuild on a more solid foundation.

The gist of the world economy for the past quarter century was a division of delusion, which led to huge bubbles. Americans pretended to have good money. Asians pretended to have a good customer. Bankers pretended to have good credits. And Wall Street pretended that toxic assets were good ones.

Asians made; Americans took. Asians saved; Americans borrowed. Americans provided the demand. Asians provided the supply. Asians built a real economy, with real money, and real factories and real skills. America’s economy was mostly a conceit, in which people became accustomed to a standard of living that very few of them could afford.

But now it has come to an end. And whom do you think will suffer most?

Our guess: the Chinese!

Eighty years ago, America was in China’s position. It was the world’s young, growing, dynamic economy. Manhattan soared then as Shanghai soars now. But when the collapse came in the ’30s, the demand for American goods shriveled. Foreign and domestic purchasers pulled in their belts and cancelled their orders. For a while, America was out of business. It was only at the onset of WWII that the orders started coming in again in massive quantities.

This time, it’s China that’s going out of business.

Yes, dear reader, China is going to suffer even more than the United States. At least in the short run. America will lose its position in the world. The dollar will lose its status as the world’s reserve currency. Americans will be beaten up – first by deflation, then by inflation. When it is over, they will be poorer, wiser, and probably better people… With a little luck and good leadership, maybe they can sink into a graceful post-imperial poverty…followed by genuine prosperity.

That is the story we’ll be covering in The Daily Reckoning going forward. It is the story of BUSTS. Companies will go bust. Governments will go bust (Ireland and Iceland are already effectively broke.) Households will go broke by the millions. And, eventually, even the U.S. government itself will go bust. (A bankruptcy that will most likely be disguised by inflation…)

But China! There, the story will be even more dramatic…even more dangerous…even more explosive!

*** “Time to mobilize for all-out war,” says a headline in the Financial Times, speaking of saving Britain’s banks from themselves. But this could just as well refer to President Obama’s attack on the correction. Nobody wants a correction. And Team Obama has pledged to fight it to the death.

Which is why we will stick with our “Trade of the Decade”. Buy gold on dips; sell stocks on rallies. This trade – announced 9 years ago – has been good to us. Gold has closed every single year ahead of where it started. From under $300 an ounce it went up over $1,000 – briefly. Now, it trades in the $800 range.

What do you think, dear reader? Is the gold bull market over? Are the troubles in the world financial system all taken care of? Is it time for another bust in the gold market – the only market (aside from U.S. Treasuries) to resist last year’s sell-off?

“My one recommendation for the longer term,” says Felix Zulauf in Barron’s, “is physical gold. Consider the basic set-up: World economies are so weak that we are seeing government stimulation of historic proportions. At first this is deflationary, but it will become inflationary. Gold is the only currency that won’t get devalued. It will be revalued.

“If the Fed’s liabilities had to be covered in gold, it would sell for more than $6,000 an ounce. We aren’t going back to the gold standard, but the markets won’t trust the central banks anymore. Gold is a very slow bull market…the gold market could have a shakeout in the next 6 months, and the price could fall back to $700 an ounce or below from today’s $850. But two years from now it will be a lot higher. It is one of the few commodities that held up during the forced liquidation of almost everything else. ”

*** If the United States catches the flu…the rest of the world throws up.

And now, with markets retching all over the planet, finance ministers are getting together to come up with a global solution. Somehow, demand must be stimulated in Asia. Supply must be coaxed out of the United States. Balance must be restored, they say.

But don’t hold your breath. Any global bailout plan is bound to be a bad one. Because what the world really needs is a correction. And no country wants one. Instead, each nation does its best to push the correction onto its neighbors. An old friend, Lord Rees-Mogg, adds further comment:

“Between the mid nineteenth and mid twentieth century, there had been a vigorous debate about the causes of the trade cycle, and of the crises which had upset the growth of the world economy.

“That debate had, however, never reached a conclusion. Among economists there was no consensus on what caused the crises to occur or on what measures would help to stabilise another depression…

“…there are at least five different alleged causes, which are still arguable. If the Central Bankers and Treasury Ministers do not agree on the cause of the present crisis they are not likely to agree on the remedy. One needs to keep theory in mind because it influences decision-making.

“However, we are beginning to see that there is a consensus developing on the policy that is needed. Economists and politicians are concentrating on the need to restore confidence. The Inaugural Address of President Barack Obama repeated the theme of Franklin Roosevelt’s Address in March, 1933: ‘We have nothing to fear, but fear itself.’ He also attacked the greed and irresponsibility of the bankers, who had behaved just as badly as they did in the early 1930s. The practical action of Governments around the world is to increase the money supply until businesses will borrow and banks will lend. Everyone recognises that this makes a risk of excessive inflation of the money supply, but it is a risk which Governments feel they have no choice but to take. They are not trying to rebalance the world economy; they are desperate to relight the boiler. In the end they will succeed.”

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.

Good article as always. Personally I think governments and central banks are chasing mirages and rainbows if they think a bank is ever going to be satisfied with any amount of free money. How good does the bank’s balance sheet need to look before it decides it has enough money and is willing to lend again? The biggest mistake the government could have ever made was to show the banks that it was prepared to give them money for their mistakes. Once banks get the whiff that all they have to do is cry poor and the government and central… Read more »

…senor bernanke…how we can get out of here..?…” relax ricardo, there’s nothin’ ta fear from the bottomless pit of fiat finance except the fear of falling itself….we induce savers to coinfidently…uh connfidently enter the hole and join us, with their money bags of course…then we climb over their bodies using them as a human ladder to get ourselves out…then, we fill the hole with water aka liquidity and let the rest float to the top…then we pick out the best apples and take one bite out of each one as our fee for saving them…then throw them over there, into… Read more »

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